Ideally, every decision we make in life involves consideration of both the pros and cons of possible outcomes. For example, the decision to eat a piece of chicken after its expiration date should be based not only on the possibility of a tasty dinner, but also on the possibility of an unpleasant gastrointestinal reaction.
In other words, most things in life have advantages and disadvantages, and our actions should, but not always, be based on whether the advantages outweigh the disadvantages. While many poor decisions can occur as a result of not considering the downsides, just as many poor decisions are the result of not understanding the downsides, rather than not considering them at all.
Most people know that irresponsible financial behaviors can give you a bad credit score, for example, but many people tend to underestimate the many downsides of having bad credit. To help you put things in perspective for your next financial decision, here are three of the biggest downsides to having bad credit.
1. You have a high probability of being rejected for new credit
At its heart, having bad credit is basically like walking around with a sign that says, “I can’t handle debt.” At least, that’s how most creditors are going to interpret your poor credit history and low credit score when you come to apply for a line of credit.
That’s because lenders use your credit reports and scores as a means of determining your credit risk, or how likely you are to repay what you borrowed. Therefore, if you have a history of defaulting or defaulting on debts, lenders will not want to give you more money and will reject your application for new credit.
Think of it this way: If you lend your neighbor your lawnmower in June but never return it, how likely are you to lend him your snowplow in December?
Since most major banks have a fairly low risk tolerance, consumers with poor credit have limited options in finding a credit card or loan. That is, you’ll see lists of subprime lenders who specialize in high-risk, bad-credit applicants, lenders who aren’t exactly known for their affordability or top-tier rewards. Which brings us to the next big downside to bad credit: expenses.
2. Creditors, landlords, and utility companies will charge you more
It took a few tries, but you finally found a subprime lender who will work with you. Great, the hard part is over, right? Wrong. Lest you think qualifying for new credit is the one big downside to having bad credit, just look at how much that credit will cost you.
As we mentioned, your credit score is what lenders use to determine your credit risk. High-risk applicants are the most likely to default (not pay), so lenders willing to work with poor credit consumers have to find some way to balance risk. They do this by raising interest rates and adding additional fees.
As an example, consider a $10,000 car loan repaid over three years. Applicant A, who has an excellent credit score of 750, will likely be offered an APR of around 3.5%, which means Applicant A will pay around $550 in interest over the three years.
At the same time, Applicant B, who has a low credit score of 580, had to use a subprime lender to get a car loan of the same size. The subprime lender charged Applicant B a 10% APR, which means Applicant B will pay more than $1,600 in interest over three years.
What’s worse, it’s not just lenders and credit card issuers that will charge you more for having bad credit. You’ll likely face a credit check when applying for a new apartment or setting up utilities at a new location, and having poor credit can result in being charged a larger security deposit than you would otherwise would have to provide.
3. You may miss out on valuable financial opportunities
An important part of finance and accounting, opportunity cost is basically the consideration of what you’re missing out on when you make the decision to do something else. For example, if you choose to spend your last $5 at a fancy cafe, the opportunity cost might be that $5 hamburger you don’t eat later.
When it comes to your credit, having bad credit is fraught with opportunity costs. Take credit cards, for example. With bad credit, you’re stuck using subprime or secured credit cards that likely cost a lot without offering much. In contrast, if you had good credit, you could earn hundreds of dollars in credit card rewards and benefits every year simply by using the right credit card.
And it goes beyond credit cards. Drivers with good credit can get dealer incentives when they buy a new car, and you can even get insurance discounts for having a healthy credit profile.
Don’t forget the extra money you’ll likely need to provide when you rent a new apartment. Let’s say you’re required to put down a $1,000 security deposit when you move in due to bad credit. That money could easily earn you dividends in your retirement account if it didn’t go to waste in the owner’s bank account.
Don’t let bad credit stop you
Although it is our own decisions that often lead to bad credit, few of us actively choose to sink our credit scores. You can end up with bad credit as a result of a series of seemingly minor decisions made without considering the consequences. However, knowing these top three drawbacks to bad credit will hopefully help you gain perspective when making your next financial decision, big or small.
For consumers who already have credit problems, these drawbacks are likely to be everyday considerations. But they don’t have to be lifelong obstacles. You can rebuild bad credit over time by practicing responsible credit habits. You can also use credit repair to remove any errors or unsubstantiated accounts that are lowering your score.
The most important rule for building credit is to always, always, always pay your bills on time. Your payment history is worth up to 35% of your credit score, and late payments can cause you to lose dozens of points with a single mistake. You’ll also want to make sure you keep credit card balances low and borrow only what you can repay as agreed.
With time and diligence, even the worst credit can be rebuilt, freeing you from the many drawbacks of bad credit. Even better, having good credit has many advantages that will make the hard work worth it.